What is a mutual fund?

A mutual fund is essentially a way for a group of investors to pool their money and achieve a predetermined investment goal. A fund manager does research and makes decisions as to which securities (e.g. stocks and bonds) to purchase. Whereas investing in a particular stock makes you a shareholder of the stock, investing in a mutual fund makes you a shareholder of the fund.

Mutual funds are easy to invest in because they do not require you to decide what stocks or bonds to buy. Also, they allow you to purchase securities at much lower rates than if you invested in the same stocks or bonds on your own.

Diversification

Mutual funds also offer diversification, which is the concept of spreading money out over many types of investments rather than putting "all your eggs in one basket." Diversifying one's holdings is a common technique for reducing risk. On a small level, diversification would involve buying multiple stocks and/or bonds. Mutual funds often purchase hundreds or thousands of securities, diversifying in a predetermined category such as growth companies or low-grade corporate bonds.

Types of Mutual Funds:

• Bond Funds
  Bond funds are mutual funds which invest in bonds. There are four primary types of bond funds: municipal bond funds, which use tax-exempt, government-issued bonds; corporate bond funds, which use the debt obligations of corporations in the US; mortgage-backed securities funds, which use residential mortgages; and US government bond funds, which use treasury or government securities. Bond funds are also categorized according to maturity. Maturity has to do with the date the borrower must pay back the money borrowed; for this reason, there are short-, intermediate-, and long-term bonds.
  
  
• Index Funds
  Index funds are based on mimicry. These funds are designed to mimic a given index (such as NASDAQ or the S&P 500). A small group of funds, or index, is chosen to represent a segment of the market, which can be accomplished by purchasing a small number of shares of every stock in the chosen market. The funds manager merely strives to match the chosen index rather than to find hot stocks or deals. These funds are generally more cost-efficient than other mutual funds.
  
  
• International Funds
  International funds are not restricted to investing in domestic companies. These include global funds (investing in US and foreign companies), foreign funds (investing mostly abroad), country-specific funds (investing in companies based in one country or region of the world), and emerging markets funds (focusing on smaller, developing countries).
  
  
• Money Market Funds
  Money market funds are low-interest mutual funds which typically produce interest rates twice those of a savings account. These funds offer a high level of liquidity, meaning that you can cash out easily and often write checks from your money market account. These funds are available through many banks, but they are not FDIC-insured.
  
  
• Sector Funds
  While they are considered less diversified than other mutual funds, sector funds offer diversification within a particular industry or market segment. Sectors include health care, automotive, technology, etc. These funds choose a sector and invest in companies in that sector.
  
  
• Stock Funds
  Stock funds, or equity funds, are popular among younger investors, as they typically offer larger returns but higher risk than other types of funds. As the name implies, stock funds involve the purchase of stocks.
  
  The most common types of stock funds are organized either by strategy or by size: Strategy-based funds include growth funds (which invest in what are believed to be fast-growing companies, which rarely provide income and are sometimes considered risky investments), value funds (which invest in apparently overlooked or out-of-favor companies, which generally provide dividends), and blend funds (which are a hybrid of growth funds and value funds).
  
  Size-based funds include large-cap funds (which typically invest in blue-chip stocks with a market value of $9 billion or more), mid-cap funds (which typically invest in companies with a market value between $1 billion and $9 billion), and small-cap funds (which typically invest in up-and-coming companies with a market value of less than $1 billion, who tend to use profits to grow rather than pay dividend.